For Immediate Release Monday, June 28, 2004
For More Information Contact: Louise Marshall, (212) 901-6000; lmarshall@isda.org
ISDA’s
assessment of the outcome of the review process is largely positive. The approach taken to credit risk in particular
is considerably more risk-sensitive and better aligned with firms’ internal
risk management practices than the current Accord. ISDA is pleased to have been
able to contribute to the Basel Committee’s thinking on this front, and to
assist in the calibration of the new Internal Ratings Based approach to credit
risk capital.
Although
originally opposed to the application of an operational risk charge,
ISDA views the spectrum of approaches proposed by the Committee as delivering
flexibility of choice. The Advanced Measurement Approach in particular provides
firms with the ability to measure and model risk as well as to reflect internal
risk mitigation policies in the determination of their capital requirement.
ISDA
also welcomes the improved recognition of credit risk mitigation by the
Committee, notably the expanded range of eligible financial collateral, the
recognition of commodity collateral, and the adoption of a portfolio approach to
measuring counterparty risk against securities financing transactions.
There
remains however a number of issues of
concern to ISDA and its membership:
Implementation
of the Accord
The
Accord leaves open a number of national discretions, which may result in
inconsistent approaches being adopted by different regulators. ISDA believes
the number of discretions should be reduced to avoid creating an uneven playing
field for firms.
Pillar
II of the Accord establishes the right for regulators to apply additional
capital requirements. These capital add-ons and the process by which they are
determined cannot easily be harmonized across the G-10. There is a need for
regulators to compare approaches in order to avoid serious inconsistencies.
ISDA
believes a lead supervisor should be appointed to guarantee coordination of
home and host supervisors’ review of a group’s capital adequacy and is working
with the Accord Implementation Group of the Basel Committee and the Committee
of European Banking Supervisors to help foster consistent, transparent
interpretation and implementation at international level.
Credit
risk mitigation
Capital
treatment of double default risk arising from the purchase of unfunded credit
protection has not been addressed. Ironically, industry concerns regarding
double default were among key catalysts for reform of the Accord in 1999. The
Committee has maintained its current approach to double default, whereby firms
have to set aside capital assuming a worst case joint default scenario between
the protection seller and the underlying credit on which protection is
acquired. This approach is overly conservative and discourages prudent risk
mitigation by failing to recognize the greater protection provided by
guarantors whose credit quality is not significantly correlated with that of
the underlying issuer. ISDA is hopeful that a more risk-sensitive treatment can
be designed based on extensive research conducted by the Federal Reserve Board.
Counterparty
risk
Thus
far, capital treatment of counterparty risk arising from derivative
transactions has not been addressed. However ISDA welcomes the Committee’s
decision to coordinate with IOSCO in re-assessing the issue. ISDA and its member
firms have met with the joint Basel/IOSCO working group and are hopeful a
change can be brought to the measurement of future exposure arising from both
derivatives and securities financing transactions by the end of March 2005.
ISDA has also raised with the regulators the issue of short-term maturity
exposures, which it believes are treated too harshly under the New Accord.
Portfolio
credit risk modeling
When the Basel Committee issued
its first consultation paper on the Basel Accord Review, it decided not to
allow banks to use internal portfolio credit risk models to determine
regulatory capital requirements. This decision was based on the fact that
commonly used models appeared to yield widely varying results for the same
portfolios. The Committee nevertheless expressed willingness to monitor
developments in this area. ISDA believes such models and their understanding by
firms have matured, and that there is evidence suggesting that convergence in
output numbers has improved. ISDA is participating in a survey of credit
capital models with a view to estimating the degree of convergence of capital
estimates across a broad range of models. This work will feed into our advocacy
efforts with the Basel Committee.
In
conclusion, it is the sincere hope of ISDA and its membership that the Basel
Committee will work on the issues listed above with a view to achieving
progress within a reasonable timeframe. ISDA trusts that the Committee will
continue its productive dialogue with the Association and its membership and
will share with the industry its program as it moves towards Implementation.
ISDA is the global trade association representing leading participants in the privately negotiated derivatives industry. ISDA was chartered in 1985, and today has more than 600 member institutions from 46 countries on six continents. These members include most of the world's major institutions that deal in privately negotiated derivatives, as well as many of the businesses, governmental entities and other end users that rely on over-the-counter derivatives to manage efficiently the financial market risks inherent in their core economic activities. Information about ISDA and its activities is available on the Association's web site: www.isda.org